The Treatment of Ipso Facto Clauses in Canada

Transcription

1 Document generated on 09/29/ :53 p.m. McGill Law Journal The Treatment of Ipso Facto Clauses in Canada Adrienne Ho Volume 61, Number 1, September 2015 URI: id.erudit.org/iderudit/ ar DOI: / ar See table of contents Publisher(s) McGill Law Journal / Revue de droit de McGill ISSN (print) (digital) Explore this journal Cite this article Ho, A. (2015). The Treatment of Ipso Facto Clauses in Canada. McGill Law Journal, 61(1), doi: / ar Article abstract Whether a debtor is an individual or a sophisticated financial institution, a common issue that arises is whether its insolvency alters the rights of the parties with whom the debtor has entered into contracts. Could the non-defaulting party to the contract, on the basis of the debtor s insolvency, terminate or amend the contract? Could it demand accelerated payment? Many parties preserve contractual rights, through what are commonly known as ipso facto clauses, to terminate and amend contracts or to demand an accelerated payment in the event that a counterparty to the contract becomes insolvent. Despite recent amendments to the Bankruptcy and Insolvency Act (BIA) and the Companies Creditors Arrangement Act (CCAA), the validity of ipso facto clauses, outside the context of derivatives contracts, is an issue that has not been thoroughly addressed in the Canadian literature. This article will trace the anti-deprivation rule in England, culminating in the United Kingdom Supreme Court s leading case: Belmont Park Investments PTY Ltd. v. BNY Corporate Trustee Services Ltd. and Lehman Brothers Special Financing Inc. It will then explore to what extent recent amendments to the BIA and the CCAA have displaced the common law rule in Canada. Both the BIA and the CCAA have nullified ipso facto clauses in some but not all situations, the most notable exceptions being cases involving corporate bankruptcies and receiverships. This article will conclude with a discussion of the codified exceptions to the common law principles and whether the Canadian jurisprudence might incorporate some of the modifications to the anti-deprivation rule introduced by Lord Collins in Belmont. Copyright AdrienneHo, 2015 This document is protected by copyright law. Use of the services of Érudit (including reproduction) is subject to its terms and conditions, which can be viewed online. [ This article is disseminated and preserved by Érudit. Érudit is a non-profit inter-university consortium of the Université de Montréal, Université Laval, and the Université du Québec à Montréal. Its mission is to promote and disseminate research.

2 McGill Law Journal Revue de droit de McGill THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA Adrienne Ho* Whether a debtor is an individual or a sophisticated financial institution, a common issue that arises is whether its insolvency alters the rights of the parties with whom the debtor has entered into contracts. Could the non-defaulting party to the contract, on the basis of the debtor s insolvency, terminate or amend the contract? Could it demand accelerated payment? Many parties preserve contractual rights, through what are commonly known as ipso facto clauses, to terminate and amend contracts or to demand an accelerated payment in the event that a counterparty to the contract becomes insolvent. Despite recent amendments to the Bankruptcy and Insolvency Act (BIA) and the Companies Creditors Arrangement Act (CCAA), the validity of ipso facto clauses, outside the context of derivatives contracts, is an issue that has not been thoroughly addressed in the Canadian literature. This article will trace the antideprivation rule in England, culminating in the United Kingdom Supreme Court s leading case: Belmont Park Investments PTY Ltd. v. BNY Corporate Trustee Services Ltd. and Lehman Brothers Special Financing Inc. It will then explore to what extent recent amendments to the BIA and the CCAA have displaced the common law rule in Canada. Both the BIA and the CCAA have nullified ipso facto clauses in some but not all situations, the most notable exceptions being cases involving corporate bankruptcies and receiverships. This article will conclude with a discussion of the codified exceptions to the common law principles and whether the Canadian jurisprudence might incorporate some of the modifications to the antideprivation rule introduced by Lord Collins in Belmont. Lorsqu un débiteur devient insolvable, qu il s agisse d un individu ou d une institution financière complexe, la question se pose à savoir si son insolvabilité affecte les droits des parties avec lesquelles le débiteur a conclu un contrat. La partie non-défaillante pourrait-elle ainsi mettre fin ou modifier le contrat sur la base de l insolvabilité du débiteur? Pourrait-elle demander un paiement accéléré? Il est commun que les parties maintiennent leurs droits contractuels à travers des clauses ipso facto, leur permettant de modifier, de mettre fin aux contrats ou de demander un paiement accéléré lorsqu une autre partie au contrat devient insolvable. Malgré de récentes modifications à la Loi sur la faillite et l insolvabilité (LFI) et à la Loi sur les arrangements avec les créanciers des compagnies (LACC), la validité des clauses ipso facto, en dehors du contexte des contrats dérivatifs, est un problème qui n a pas encore été adressé en profondeur par la doctrine canadienne. Cet article retracera le parcours du principe légal de non-appauvrissement en Angleterre, ayant abouti à la Cour suprême du Royaume-Uni dans l arrêt Belmont Park Investments PTY Ltd. v. BNY Corporate Trustee Services Ltd. and Lehman Brothers Special Financing Inc., avant d examiner dans quelle mesure les modifications récentes à la LFI et à la LACC ont supplanté la règle de common law au Canada à ce sujet. La LFI et la LACC ont toutes deux invalidé les clauses ipso facto dans plusieurs situations, exceptés pour les cas de faillite d entreprise et de mise sous séquestre. Cet article analysera finalement les exceptions codifiées aux principes de common law et l intégration potentielle à la jurisprudence canadienne de certaines modifications de la règle du nonappauvrissement introduites par Lord Collins dans l arrêt Belmont. * The views expressed in this article are solely those of the author and do not reflect the opinion of any institution or law firm where the author has been professionally employed. The author wishes to thank Professor Jim Phillips, Professor Anthony Duggan, Nicholas Rolfe, Sze Yee Ling, and Paul Migicovsky for their comments on earlier drafts of this article as well as the anonymous reviewers and the editors of the McGill Law Journal. Any errors are the author s own. Adrienne Ho 2015 Citation: (2015) 61:1 McGill LJ 139 Référence : (2015) 61:1 RD McGill 139

3 140 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL Introduction 141 I. Overview of Insolvency Law Regimes 142 A. England 142 B. Canada 144 C. The Effect of Bankruptcy and Insolvency Proceedings on the Debtor s Contracts 145 II. The Anti-Deprivation Rule in England 147 A. Introduction 147 B. The Pari Passu Principle 148 C. Statutory Anti-Avoidance Provisions 149 D. Early Applications of the Anti-Deprivation Rule 151 E. Where the Anti-Deprivation Rule Has Not Been Applied Limited and Absolute Interests Deprivation Took Place for Reasons Other than Bankruptcy Good Faith and the Parties Intentions 158 III. The Treatment of Ipso Facto Clauses in Canada 163 A. Introduction 163 B. The Anti-Deprivation Rule in Canadian Jurisprudence 165 C. A Codification of the Anti-Deprivation Rule? The Application of the Statutory Provisions and the Anti-Deprivation Rule The Affected Parties Timing Requirements Deprivation Took Place for Reasons Other than Bankruptcy Limited Protection for Flawed Assets Distinctions Between Consumers, Insolvent Persons, and Eligible Financial Contracts 180 D. Where the Statutory Provisions and the Anti- Deprivation Rule May Not Apply Statutory Exceptions to the General Prohibition in the BIA and the CCAA Good Faith and the Canadian Anti-Deprivation Rule 185 Conclusion 187

4 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 141 Introduction Whether a debtor is an individual or a sophisticated financial institution, a common issue that arises is whether its insolvency alters the rights of the parties with whom the debtor has entered into contracts. Several questions arise. Could the non-defaulting party to the contract, on the basis of the debtor s insolvency, terminate or amend the contract? Could there be a demand for accelerated payment? Many parties preserve contractual rights, through what are commonly known as ipso facto clauses, to terminate and amend contracts or to demand an accelerated payment in the event that a counterparty to the contract becomes insolvent. Despite recent amendments to the Bankruptcy and Insolvency Act 1 and the Companies Creditors Arrangement Act, 2 the validity of ipso facto clauses, outside the context of derivatives contracts, 3 is an issue that has only received limited attention in the Canadian literature. This article will focus on the treatment of contracts in cases involving individual and corporate bankruptcies as well as proceedings under the BIA and the CCAA. Unlike both England and the United States, Canadian insolvency law is unique because both common law principles and statutory provisions could apply, depending on the nature of the debtor involved and the particular facts of each case. Whereas the common law principle, known as the anti-deprivation rule or fraud upon the bankruptcy law rule, is over two hundred years old, statutory developments in this area have only materialized significantly in Canada over the last two decades. Thus, this article will explore to what extent these statutory developments have codified or displaced common law principles. The BIA and the CCAA have provided some welcomed clarity that ipso facto clauses are generally void in cases involving Division I proposals, consumer proposals, proceedings under the CCAA, and individual bankruptcies. The status of such clauses with respect to corporate bankrupts and receiverships is less clear, but recent jurisprudence suggests that the common law anti-deprivation rule is still very much a facet of Canadian law. This article has been divided into three main parts. Part I begins with a brief overview of the insolvency regimes in both England and Canada. It then provides a foundation as to why the issue of the treatment of a debt- 1 RSC 1985, c B-3 [BIA]. 2 RSC 1985, c C-36 [CCAA]. 3 See e.g. Rupert H Chartrand, Edward A Sellers & Martin McGregor, Selected Aspects of the Treatment of Derivatives in Canadian Insolvency Proceedings: Time for a Re- Set? (2011) Ann Rev Insolv L 1. Derivative contracts, swap agreements, etc. are eligible financial contracts under both the BIA and CCAA and are largely exempted from many of the provisions discussed in Part III of this article (see BIA, supra note 1, ss 65.1(7), 66.34(7), 84.2(7); CCAA, supra note 2, s 34(7)).

5 142 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL or s contract in the event of its insolvency is important. Part II will trace the development of the anti-deprivation rule in England, and it will conclude with a categorization of cases where the rule has been found not to apply, with a particular focus on the changes to the scope of the rule as a result of the United Kingdom Supreme Court s decision in Belmont Park Investments PTY Ltd. v. BNY Corporate Trustee Services Ltd. and Lehman Brothers Special Financing Inc. 4 This article will then move on to the Canadian context in Part III and start with an overview of the anti-deprivation rule in Canadian jurisprudence. Then, using the concepts explored in Part II as a framework for discussion, this article will explore to what extent the recent amendments to the BIA and the CCAA have displaced the common law in Canada. Both the BIA and the CCAA have nullified ipso facto clauses in some but not all situations, the most notable exceptions being cases involving corporate bankruptcies and receiverships. Part III will discuss the codified exceptions to the statutory principles and explore the issue of whether the Canadian jurisprudence might incorporate some of the modifications to the anti-deprivation rule introduced by Lord Collins in his seminal decision in Belmont, before concluding. I. Overview of Insolvency Law Regimes A. England I begin by briefly elucidating the various types of insolvency regimes available. In England, individuals, companies, and partnerships are largely governed by the Insolvency Act Insolvent individuals can be subject to debt relief orders, 6 voluntary arrangements, or bankruptcy orders. Under an individual voluntary arrangement (IVA), creditors can agree to a debtor s proposal in satisfaction of his or her debts; the process is supervised by a nominee. 7 Alternatively, the individual or other parties, includ- 4 [2011] UKSC 38, [2012] 1 AC 383 [Belmont]. 5 (UK), c 45. Note that companies may also be subject to the Companies Act 1985 (UK), c 6. The Insolvency Act 1986 has also been amended by the Insolvency Act 1994 (UK), c 7; the Insolvency Act (No 2) 1994 (UK), c 12; the Insolvency Act 2000 (UK), c 39; and the Enterprise Act 2002 (UK), c 40. See also Roy Goode, Principles of Corporate Insolvency Law, 4th ed (London: Sweet & Maxwell, 2011) at para 1-20 [Goode, Principles]. 6 Individuals who cannot afford to pay back their debts may be eligible for a debt relief order (see Insolvency Act 1986, supra note 5, Part 7A). 7 See ibid, Part VIII (especially s 253). See also Halsbury s Laws of England, Bankruptcy and Individual Insolvency, Individual Voluntary Arrangements at para 43; Donna McKenzie Skene & Adrian Walters, Consumer Bankruptcy Law Reform in Great Britain (2006) 80:4 Am Bank LJ 477 at

6 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 143 ing creditors, 8 can petition the individual debtor into bankruptcy provided that certain prerequisites are satisfied. 9 In the case of such a bankruptcy order, all of the property belonging to the debtor at the commencement of the bankruptcy is vested in a trustee. 10 The trustee then liquidates the assets and distributes them in accordance with various statutory rules. 11 As for companies, there are a few possible outcomes. Upon the application of a petition to a court, a company can be wound up. 12 As in cases involving personal bankruptcies, the liquidator obtains control of the company s assets and then realizes and disposes of them in accordance with the statutory scheme. 13 Alternatively, with company voluntary arrangements (CVAs), 14 administrations, 15 and reorganizations, 16 a company attempts to come to an arrangement with its creditors with the objective to survive as a going concern. 17 If these efforts fail, however, the company will be dissolved and wound up. 18 Finally, debenture holders can enforce their security by way of an administrative receivership although, nowadays, many would opt for an administration instead. 19 In the case of a court-initiated winding-up order, there is a statutory stay against the company during which no actions or proceedings can be commenced or continued without the court s permission. 20 A similar form of protection, known as a moratorium, is available where there is either a 8 See Insolvency Act 1986, supra note 5, s 264(1) for a list of parties that can petition an individual into bankruptcy. 9 For the grounds on which a creditor may petition a debtor into bankruptcy, see ibid, s 267(1). As for the grounds on which debtors can file for bankruptcy, see ibid, s See ibid, s 306. There are exceptions as to what falls within the bankrupt s estate (see ibid, s 283). 11 See ibid, ss ; Insolvency Rules 1986, SI 1986/1925, Part Petitions can be presented by a number of parties, including the company itself or its creditors (see Insolvency Act 1986, supra note 5, ss 73ff). 13 See ibid, ss 165ff. 14 See ibid, Part I. 15 See ibid, Part II. 16 In England, the difference between restructurings and administration is that the former is arranged contractually outside the formal framework of corporate insolvency law (see Goode, Principles, supra note 5 at paras 1-35, 1-51). 17 See ibid at paras 1-31 to See ibid at paras 1-31, See ibid at para 1-38 for a description of the different categories of receivership. 20 See Insolvency Act 1986, supra note 5, s 130.

7 144 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL CVA or an administration order. 21 Parallel forms of protection are also available when the debtor is an individual. Once a bankruptcy order has been made, there is usually a stay against the debtor s creditors, with an exception made for its secured creditors. 22 It is also an industry standard that IVAs provide for a stay against the debtor s creditors. 23 B. Canada Despite some differences in nomenclature, similar insolvency regimes and procedures exist in Canada. Under the BIA, both natural persons and legal persons, including companies, can be petitioned voluntarily or involuntarily into bankruptcy. 24 Once a bankruptcy order has been made, the debtor s property vests in the trustee, who then proceeds to liquidate and distribute the assets in accordance with the scheme laid out in the BIA. 25 Alternatively, both individuals and companies can file proposals under the BIA in an attempt to gain their creditors approval of an alternative plan to satisfy their debts. 26 Companies with more than $5 million in debt, though, can also opt to restructure under the CCAA, which is characterized by a higher degree of court involvement than proposals under the BIA. 27 The BIA also governs receiverships. 28 Like its English counterpart, Canadian insolvency legislation provides the debtor with a stay against its creditors. Whereas a stay under the BIA is automatic, 29 a stay under the CCAA is usually derived from a court order See ibid, Schedules A1, B1 (especially paras 42 43). In the case of CVAs, the moratorium is only effective against those creditors who are bound by the CVA (see Goode, Principles, supra note 5 at para 11-51). 22 See Insolvency Act 1986, supra note 5, ss 285(3) (4). 23 See Adrian Walters, Individual Voluntary Arrangements: A Fresh Start for Salaried Consumer Debtors in England and Wales? (2009) 18:1 Intl Insolv Rev 5 at BIA, supra note 1, ss 43, Ibid, ss 71, For commercial and consumer proposals, see ibid, Part III, Division I and Part III, Division II respectively. Although known as a commercial proposal, Division I proposals can be used by both businesses and individuals (see Office of the Superintendent of Bankruptcy Canada, You Owe Money: Process for Division I Proposals, online: Industry Canada < 27 See CCAA, supra note 2. See also Roderick J Wood, Bankruptcy and Insolvency Law (Toronto: Irwin Law, 2009) at [Wood, Bankruptcy]. 28 See BIA, supra note 1, Part XI. 29 Ibid, ss 69, 69.3(1). 30 CCAA, supra note 2, s

8 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 145 C. The Effect of Bankruptcy and Insolvency Proceedings on the Debtor s Contracts The principles discussed in this article, with some exceptions, are generally applicable in both the bankruptcy and reorganization proceedings described above. This article will focus on how these insolvency proceedings alter parties contractual rights, with a particular emphasis on the Canadian context. There are two possible viewpoints. The first is the debtor s rights in relation to the contract that is, the right to disclaim, affirm, and assign contracts a topic that has been thoroughly scrutinized in the literature. 31 The second, which will be explored in this article, is the counterparty s rights upon learning that the debtor has become insolvent. To ensure clarity, the term debtor will denote the party, whether an individual, corporation, or a partner in a partnership agreement, that has entered into insolvency proceedings. The counterparty to the contract will be referred to as the non-defaulting party. Although this article s focus is on Canadian law, it is useful to reference its American counterpart to better elucidate some of the concepts discussed. Generally, bankruptcy itself neither terminates a contract nor does it constitute a breach of contract. 32 Parties, however, can use ipso facto clauses to preserve certain contractual rights in the event that one of the contracting parties has entered into bankruptcy or insolvency proceedings, including the right to terminate the contract. 33 Ipso facto clauses can also provide, upon one of the parties insolvency, a right to amend or cancel an agreement, to demand the return of goods, or to make a liquidated damages claim. 34 The term ipso facto clause stems from the American context, where they are largely prohibited; Title 11 of the United States Code 35 nullifies contractual clauses that prohibit debtors from using, selling, or leasing property as a result of an insolvency or filing under a 31 See e.g. R Graham Phoenix & Aubrey E Kauffman, Enhancing the Prospects of a Viable Recovery: Ontario Court Reinforces the Use of CCAA Disclaimer Provisions in the Context of a Sale Process (2013) 28:3 BFLR 549; Pamela Kraus, Unsettled Existence: The Fate of Licensed Intellectual Property Rights upon the Bankruptcy or Insolvency of the Licensor (2005) 19:1 IPJ 149; David B Bish, Who s in the Driver s Seat? A Landlord Perspective on a Retail Tenant s Insolvency Proceedings (2008) 42 CBR (5th) 159; Daniel Frajman, Leases and Intellectual Property: Counter-Intuitive Amendments (2011) 77 CBR (5th) See Wood, Bankruptcy, supra note 27 at 160. For a discussion on executory contracts, see Thomas H Jackson, Translating Assets and Liabilities to the Bankruptcy Forum (1985) 14:1 J Legal Stud 73 at See Wood, Bankruptcy, supra note 27 at See Anthony Duggan et al, Canadian Bankruptcy and Insolvency Law: Cases, Text, and Materials, 3rd ed (Toronto: Edmond Montgomery, 2015) at USC (2010) [Bankruptcy Code].

9 146 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL Bankruptcy Code provision. 36 The Bankruptcy Code also prohibits parties from contracting to prevent the debtor s property from forming part of its estate because of it entering into insolvency proceedings. 37 Ipso facto clauses, indeed, can be problematic. First, where such clauses reserve the right of a non-defaulting party to terminate a contract upon a debtor s insolvency, a debtor s ability to reorganize and survive as a going concern may be stymied if the non-defaulting party supplied goods and services vital to the debtor s business. Ipso facto clauses may also prevent a trustee from affirming the contract unless the non-defaulting party consents. 38 The term executory contract originates from the American context. Although its meaning has been disputed in both the literature and the jurisprudence, American courts have largely agreed that a situation would be characterized as an executory contract where both parties have outstanding obligations and a party s failure to perform would be a material breach. 39 For example, a party agrees to sell 1,000 widgets for $1,000 to a debtor with delivery to be made in thirty days. On the date of the debtor s bankruptcy, neither side has performed its obligations, making the arrangement an executory contract. The debtor, or its trustee, has the option of affirming, disclaiming, or assigning the contract. 40 The trustee would prefer to affirm the contract if its completion would benefit the debtor s estate because, in this case, the non-defaulting party would need to deliver the widgets. The trustee would then be obligated to pay the purchase price. An ipso facto clause, which allows the non-defaulting party to terminate the contract immediately upon learning the debtor has become insolvent, would in turn prevent the trustee from exercising its option to affirm the 36 Ibid, 363. See also Paul Rubin, Not Every Ipso Facto Clause is Unenforceable in Bankruptcy (2013) 32:7 Am Bankr Inst J 12 at Bankruptcy Code, supra note 35, 541(c)(1). See also Rubin, supra note 36 at See Wood, Bankruptcy, supra note 27 at See Carl N Pickerill, Executory Contracts Re-Revisited (2009) 83:1 Am Bank LJ 63 at Executory contracts are governed by the Bankruptcy Code, supra note 35, 365. Pickerill s article provides a useful survey of the two main approaches to the issue of executory contracts. The first is the material breach analysis which stems from Countryman s seminal articles on the topic (see Vern Countryman, Executory Contracts in Bankruptcy: Part I (1973) 57:3 Minn L Rev 439; Vern Countryman, Executory Contracts in Bankruptcy: Part II (1974) 58:3 Minn L Rev 479). The second approach, which was adopted by Westbrook and Andrew, is the functional analysis (see Jay L Westbrook, A Functional Analysis of Executory Contracts (1989) 74:2 Minn L Rev 227; Michael T Andrew, Executory Contracts in Bankruptcy: Understanding Rejection (1988) 59:4 U Colo L Rev 845; Michael T Andrew, Executory Contracts Revisited: A Reply to Professor Westbrook (1991) 62:1 U Colo L Rev 1). 40 See Wood, Bankruptcy, supra note 27 at 367.

10 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 147 contract later on a reason why the Bankruptcy Code in the United States also nullifies ipso facto clauses in cases involving executory contracts. 41 Ipso facto clauses, however, are enforceable in certain types of agreements such as securities contracts, as well as commodities and forward contracts. 42 As will be seen in Part III, Canadian insolvency legislation provides a similar exemption for these types of agreements. Second, ipso facto clauses may compel the debtor to transfer a portion of its assets or to make an accelerated payment to the non-defaulting party. In both situations, the value of the debtor s estate is reduced, which is contrary to the general objective of insolvency legislation to maximize the value of assets available to be paid out to the debtor s creditors. 43 Finally, ipso facto clauses provide a mechanism by which a non-defaulting party could circumvent the statutory scheme of distribution. That is, such clauses would compel the debtor to pay the non-defaulting party even if it would not otherwise have had a valid claim under the relevant insolvency statute. II. The Anti-Deprivation Rule in England A. Introduction In England, the treatment of a debtor s contracts upon its insolvency has largely been crafted by the common law in the form of the fraud upon the bankruptcy law principle or the anti-deprivation rule. Briefly, the purpose of the rule is to prevent contractual arrangements designed to remove assets at the commencement of the bankruptcy or winding-up process, that are held by the debtor, on the ground that such arrange- 41 Bankruptcy Code, supra note 35, 365(e)(1), 365(b)(2). The exception being that, in certain situations, the performance or assignment of a contract by the debtor can be opposed by a non-defaulting party. In cases where the debtor has assumed an executory contract, the counterparty cannot demand payment on the basis of an ipso facto clause. See also Rubin, supra note 36 at See Bankruptcy Code, supra note 35, Other types of agreements include repurchase agreements, swap agreements, master netting agreements, and safe harbor contracts. The exemption for safe harbor contracts only applies to Chapter 15 proceedings. See also Rubin, supra note 36 at See UNCITRAL, Legislative Guide to Insolvency Law (New York: UN, 2005) at 10 11, online: UNCITRAL < The United Nations General Assembly recommended that member states consider the UNICITRAL guide when it came to revising or adopting their insolvency legislation (see Legislative Guide on Insolvency Law of the United Nations Commission on International Trade Law, GA Res 40, UNGAOR, 59th Sess, Supp No 49, UN Doc A/Res/59/40 (2004)).

11 148 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL ments are contrary to public policy. 44 As seen in Part I.C., the term ipso facto clause is an American one. Since that term is largely absent in the English jurisprudence, it will not be employed in this section on English law. This Part will first explain the differences between the antideprivation rule and two similar but distinct concepts the pari passu rule and statutory anti-avoidance provisions. Then, drawing guidance from Belmont, it will highlight situations where the anti-deprivation rule has been applied and conclude with comments on the implications of Lord Collins judgment in Belmont. B. The Pari Passu Principle Despite being two distinct concepts, the pari passu principle and the anti-deprivation rule are often discussed collectively in English jurisprudence. 45 It is a long-standing principle that debts are to be paid equally that is, a debtor s liabilities should be satisfied pari passu, subject only to secured creditors claims and priorities given by statute. 46 Provisions that attempt to contract out of the pari passu principle are void as being contrary to public policy, which is known as the common law pari passu rule. 47 To distinguish between the two principles, Goode suggests that the pari passu rule could be characterized as preventing a creditor from jumping ahead of the other creditors for a slice of the pie. Satisfying this creditor s liabilities results in a corresponding diminution in the debtor s liabilities on its balance sheet. Thus, the size of the pie that is the debtor s net asset value remains unchanged. In Goode s view, though, the antideprivation rule only applies where the party that benefits from the deprivation is not a creditor, so the debtor s liabilities remain untouched. That is, the improper removal of an asset from the debtor s estate would reduce the debtor s overall net asset value, which would in turn reduce the size of the pie. 48 Although Goode s analogy is helpful in illustrating 44 See Goode, Principles, supra note 5 at para See Belmont, supra note 4 at paras 9ff. 46 This principle was established in a statute of Henry VIII in 1542 and is found today in the Insolvency Act 1986, supra note 5, s 107. See also Goode, Principles, supra note 5 at para 7-03; Colin Bamford, Principles of International Financial Law (Oxford: Oxford University Press, 2011) at para Like the anti-deprivation rule, the substance and the role of the pari passu rule have similarly been challenged (see e.g. Rizwaan Jameel Moka, Priority as Pathology: The Pari Passu Myth (2001) 60:3 Cambridge LJ 581). 47 The seminal pari passu case is British Eagle International Airlines Ltd v Compagnie Nationale Air France, [1975] 1 WLR 758, [1975] 2 All ER 390 (HL (Eng)) [British Eagle cited to WLR]. See also Belmont, supra note 4 at paras Goode, Principles, supra note 5 at para 7-03.

12 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 149 the conceptual differences between the two principles, it causes some problems in the Canadian context since, as will be seen in Part III, the provisions in the BIA and the CCAA, which nullify ipso facto clauses, do not distinguish creditors from non-creditors. C. Statutory Anti-Avoidance Provisions As Goode explains, both the anti-deprivation rule and the pari passu principle could fall under the umbrella of avoidance transactions, which also encompasses transactions at an undervalue, preferences, and dispositions made without the court s permission. 49 The anti-deprivation rule, however, is seen to be distinct from the statutory anti-avoidance provisions. Agreeing with this viewpoint in Belmont, Lord Collins recognized that in early cases where the anti-deprivation rule had been applied, little statutory protection existed against avoidance transactions. 50 Despite legislative developments aimed at prohibiting avoidance transactions, Lord Collins found the anti-deprivation rule still to be useful since it is not subject to the time limitations inherent in the statutory anti-avoidance provisions. 51 Neither Lord Collins nor the literature has thoroughly compared the anti-deprivation principle with the statutory anti-avoidance provisions. The following discussion will focus on those anti-avoidance provisions with Canadian counterparts: transactions at an undervalue and preferences. 52 First, as Part II.D. will explain, the anti-deprivation rule is applied to void a contractual provision for being contrary to public policy. That is, the parties contractually arranged ex ante what would happen should one of them become insolvent. In contrast, the application of statutory antiavoidance provisions hinges on the transaction having taken place, rather than the parties contractual arrangements. For instance, a gift from the debtor could qualify as a transaction at an undervalue whereas it would not fall under the anti-deprivation rule since the recipient of the gift was not in a contractual relationship with the debtor. 53 A second difference, 49 Ibid at para Belmont, supra note 4 at para 16. Although some anti-avoidance provisions, such as transactions at undervalue, were not introduced in England until 1986, other concepts, such as preferences, originated in the common law from the eighteenth century (see Professor David Milman, Transactional Avoidance on Insolvency: An Update on Recent Developments (2013) 26:6 Insolvency Intelligence 81 at 81 83). 51 See Belmont, supra note 4 at para See BIA, supra note 1, ss These provisions relating to preferences and transfers at an undervalue also apply under the CCAA (supra note 2, s 36.1). 53 A gift would be a transaction at an undervalue (see Insolvency Act 1986, supra note 5, ss 238, 339).

13 150 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL and one that Lord Collins briefly alluded to, 54 is that the statutory antiavoidance provisions define relevant time periods, such as in the two years leading up to the insolvency, where the transfer had to have taken place. 55 This time element, however, is not a characteristic of the antideprivation rule; its focus is on whether a contractual provision should be found void on public policy grounds. A third dissimilarity relates to the procedural elements of an application. With both transactions at an undervalue and preferences, there are strict conditions that must be satisfied for the onus of proof to be met, such as when the transaction was made and the nature of the transaction. 56 In contrast, as will be seen in Part II.D., the requirements for the application of the anti-deprivation rule have varied from case to case, but it is not necessary for the transfer to have taken place. Under the antideprivation rule, the remedy being sought is a finding that a contractual provision is void for public policy. The desired remedy in cases involving statutory anti-avoidance provisions, however, would be that the transfer was void and that it should be reversed. 57 Although the transfer of an asset may be reversed in an anti-deprivation case, the court could limit its remedy to declaratory relief that a contractual provision is void. 58 Finally, the statutory anti-avoidance provisions and the antideprivation rule differ in their views on the role of good faith. The defence of good faith is generally unavailable to defendants in transactions at an undervalue and preferences cases, except in the case of bona fide purchasers. 59 In contrast, after Belmont, the presence of good faith is one of the 54 See Belmont, supra note 4 at para See Insolvency Act 1986, supra note 5, ss , 341. There are different requirements depending on whether the person was in an arm s-length relationship with the debtor and whether the debtor is bankrupt. 56 See Insolvency Act 1986, supra note 5, ss , See also Goode, Principles, supra note 5 at paras See Insolvency Act 1986, supra note 5, ss 238(3), 239(3), 339(2), 340(2). That is, the asset is returned to the company as if the purported disposition had not taken place. Goode points out that in cases where the transfer in question does not override a charge in the property, the charge continues to attach to the recovered property. See Goode, Principles, supra note 5 at paras to for a discussion on the application of recoveries in statutory anti-avoidance cases. 58 For instance, in Belmont, supra note 4 at para 33, the UK Supreme Court granted only declaratory relief a move that was likely motivated by the Court s worry about the conflict that would arise between the differing decisions given by the two jurisdictions involved in the dispute: the UK Supreme Court in England and the Bankruptcy Court in New York. 59 See Goode, Principles, supra note 5 at para 13-98; Insolvency Act 1986, supra note 5, s 241(2)(b).

14 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 151 factors considered when deciding whether the anti-deprivation rule should apply a point further discussed in Part II.E D. Early Applications of the Anti-Deprivation Rule The remainder of this Part traces the development of the antideprivation rule, which will help put the Canadian application of this principle, discussed in Part III, into context. The anti-deprivation rule first appeared in personal bankruptcy cases. As explained in Part I.A., in a personal bankruptcy, all of the property belonging to the debtor on the date of its bankruptcy vests in its trustee. After liquidating the assets, the trustee distributes the proceeds to creditors in accordance with the statutory scheme of distribution. Thus, contractual provisions that seek to prevent certain assets from being vested in the trustee, which in turn reduce the amount of assets available for liquidation and distribution, could trigger the application of the anti-deprivation rule. From the eighteenth century until very recently, the anti-deprivation rule was largely known as the fraud upon the bankruptcy law principle. The term deprivation was not adopted in England in this context until 2002 in Money Markets International Stockbrokers Ltd. v. London Stock Exchange Ltd. 61 In fact, as seen in Part III, Canadian jurisprudence similarly refers to the rule as the fraud upon the bankruptcy law principle; the term, the anti-deprivation rule, seems to have only first appeared in Canada in the dissenting judgment of a 2012 Alberta Court of Appeal decision. 62 Nevertheless, for consistency purposes, this article will refer to the principle as the anti-deprivation rule. As Lord Collins observed in Belmont, referring to the seminal decision in Higinbotham v. Holme, 63 the anti-deprivation rule is premised on the idea that there had been some sort of a fraud upon the bankruptcy laws. 64 Higinbotham involved a provision in a marriage settlement that reserved for the wife a life interest in her husband s property, in the form of an annuity, should he become bankrupt. 65 Lord Eldon held the provision to be 60 See Belmont, supra note 4 at paras 74 79, [2002] 1 WLR 1150, [2001] 4 All ER 223 (ChD (Eng)) [Money Markets cited to WLR]. See also Belmont, supra note 4 at para Alberta Ltd v Valin Industrial Mill Installations Ltd, 2012 ABCA 62 at para 33, 64 Alta LR (5th) 163, McDonald JA (dissenting) [Valin Industrial], leave to appeal to SCC refused, (25 April 2012). A search of the term anti-deprivation on Can- LII does not come up with any additional results. 63 (1812), 34 ER 451, 19 Ves Jr 88 (Ch (Eng)) [Higinbotham cited to ER]. 64 Belmont, supra note 4 at para 75, citing Higinbotham, supra note Higinbotham, supra note 63 at 451.

15 152 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL void as it was a direct fraud on the bankruptcy laws. 66 The antideprivation rule has since been applied in a wide variety of cases, making its precise scope difficult to define a challenge recognized by Lord Collins in Belmont. 67 Nevertheless, highlighting some of the most relevant cases will provide a useful backdrop to the discussion in Part III on the antideprivation rule in Canada. The anti-deprivation rule is often applied to void contractual provisions that provide for the divestment of ownership in an asset on a debtor s bankruptcy. 68 A classic example mentioned by Lord Collins is Ex parte Jay, 69 which involved a landowner who contracted a builder to construct houses on his property. 70 They agreed that if the builder, prior to the completion of the homes, became bankrupt, the landowner could take possession of the materials on his property. 71 The Court of Appeal held that the contractual provisions that purported to forfeit the building materials to the landlord on the builder s bankruptcy were void. 72 There are numerous variations on the above example. Another wellknown case discussed by Lord Collins is Ex parte Mackay, 73 where Jeavons entered into a series of linked agreements with Brown & Co. and Cammell & Co. In the first agreement, Jeavons sold a patent to Brown in exchange for royalties. In the second agreement, Jeavons granted Brown a security interest in a lease in exchange for a loan. In the third, Brown agreed to retain half of the royalties in satisfaction of Jeavons debt. If Jeavons became insolvent or bankrupt, Brown could retain all of the royalties. It was this aspect of the third agreement that was challenged before the court. 74 The court held that Jeavons could validly create a charge in favour of Brown for half of the royalties in order to repay his loan, but that the cre- 66 Ibid at Lord Collins in Belmont, supra note 4 at para 58 agreed with this point made by Lord Neuberger MR in his judgment for the same case before the Court of Appeal: Perpetual Trustee Company Ltd v BNY Corporate Trustee Services Ltd, [2009] EWCA Civ 1160 at para 32, [2010] Ch 347 [Perpetual Trustee]. 68 See Goode, Principles, supra note 5 at para See Belmont, supra note 4 at para 62, citing Ex parte Jay, Re Harrison (1880), 14 ChD 19 (CA) (available on WL UK) [Jay]. 70 See Jay, supra note 69 at See ibid. 72 See ibid at See Belmont, supra note 4 at paras 11 12, 61, citing Ex parte Mackay, Re Jeavons (1873), LR 8 Ch App 643 (available on WL UK) [Mackay]. 74 See Mackay, supra note 73 at

16 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 153 ation of a charge in Brown s favour for the other half of the royalties was an attempt to evade the insolvency laws. 75 That is, Jeavons could not contractually arrange to prevent his property from being distributed in accordance with the bankruptcy laws. 76 The court concluded that, had Brown been allowed to keep the royalties, it would have created an unlawful additional advantage. 77 Lord Collins characterized Ex parte Mackay as belonging to a category of cases where there was an unsuccessful attempt to create a charge. 78 Ex parte Jay would also fall under this category. 79 Alternatively, the situation in Ex parte Mackay could be viewed as one where the impugned contractual provision amended the agreement by increasing the security given to a creditor or by triggering the obligation to make accelerated payments. In the event of Brown s insolvency, Jeavons could keep all the royalties rather than just half of them. As Lord Mance, who wrote the minority judgment in Belmont, observed: [T]here is no conceptual difference between removing specific property from the bankrupt estate for no consideration (Whitmore v Mason), increasing the security given to a particular creditor (Ex p Mackay) and increasing the bankrupt estate s liability to a particular creditor (In re Johns [1928] Ch 737). All these fall within the antideprivation principle. 80 In In re Johns, under a loan agreement, the son, in the event he became bankrupt, had to increase the payments made to his mother. 81 The agreement was considered void as it was designed to secure more money to the mother on her son s bankruptcy than what would have been available had he remained solvent. 82 Although Lord Mance s observation was not pivotal in Belmont, it can help elucidate some of the concepts underly- 75 See ibid at See ibid. 77 Ibid at Belmont, supra note 4 at para 61. Lord Collins also mentions Ex parte Williams, In re Thompson (1877) LR 7 ChD 138 (available on WL UK) [Williams] as another case that would fit this category (see Belmont, supra note 4 at para 61). 79 In Jay, supra note 69 at 26 27, Lord Justice Cotton was careful to note that there was nothing in the agreement that purported to give the landlord a lien on the materials. 80 Belmont, supra note 4 at para 149. Lord Mance also observed that the situations in Whitmore v Mason (1861), 70 ER 1031, 2 J&H 204 (KB) and Mackay, supra note 73 could be analyzed within the framework of the pari passu principle, again demonstrating the considerable overlap between these two rules. 81 Re Johns, Worrel v Johns, [1928] 1 Ch 737 at (available on WL UK). 82 See ibid at 748.

17 154 (2015) 61:1 MCGILL LAW JOURNAL REVUE DE DROIT DE MCGILL ing the Canadian statutory response to the anti-deprivation principle (see Part III.C.). E. Where the Anti-Deprivation Rule Has Not Been Applied Having reviewed some English cases where the anti-deprivation rule has been applied, 83 it will also be useful to examine judgments where the principle has been found not to apply. Lord Collins holding in Belmont, however, has further narrowed the scope of the anti-deprivation rule, and in doing so, has attracted its share of both support and criticism. 1. Limited and Absolute Interests English law distinguishes between absolute and limited interests. A party who transfers to a debtor an absolute interest in an asset and gives itself a right to recapture the asset would fall afoul of the anti-deprivation rule. 84 This result occurs because the non-defaulting party is attempting to remove an asset from the debtor s estate, in turn depriving the asset from the debtor s creditors. 85 The examples discussed in Part II.D. would fall under this first category. As Lord Collins characterized it, an absolute interest is defeasible on bankruptcy or liquidation by a condition subsequent 86 that being the party s insolvency. In contrast, a contractual right to terminate a limited interest in an asset conferred on another party would not infringe the anti-deprivation rule; bankruptcy is simply an event that terminates the limited interest. 87 As Gabriel Moss points out, here, the debtor s proprietary interest in the asset could be seen as being subject to a condition precedent. 88 The distinction between absolute and limited interests has been criticized because it often turns on the wording of the provision, prompting Goode, quoting from an Irish decision, to describe the distinction as little short of disgraceful to our jurisprudence when it is applied to a rule pro- 83 See Goode, Principles, supra note 5 at paras 7-09 to 7-13 for a discussion on additional examples where the fraud upon the bankruptcy law principle has been applied. 84 See ibid at para As Goode observes, though, where the beneficiary of the retransfer of the asset is a creditor, it is deemed to have contravened the pari passu rule instead. 85 See ibid. 86 See Belmont, supra note 4 at para See Goode, Principles, supra note 5 at para Goode also notes that this would not fall afoul of the pari passu rule either (ibid). 88 Gabriel Moss, Should British Eagle Be Extinct? (2011) 24:4 Insolvency Intelligence 49 at 53.

18 THE TREATMENT OF IPSO FACTO CLAUSES IN CANADA 155 fessedly founded on considerations of public policy. 89 Moss is more forgiving in his analysis, suggesting that, from the perspective of property law, the differing treatment of conditions subsequent and conditions precedent makes sense. He does, however, agree that to use this distinction to determine whether a contractual provision was subject to the antideprivation rule is difficult to reconcile with the rule s objective as being one based upon public policy. 90 Lord Collins, though, pointed out that the distinction is one that is too well established to be dislodged otherwise than by legislation. 91 Some common examples of limited interests that are terminable on the debtor s insolvency that is, where the anti-deprivation rule would not apply include provisions for the forfeiture of a lease upon winding up 92 and the termination of intellectual property licenses. 93 Although at face value there does not seem to be an outright deprivation of the debtor s estate, Goode brings up the valid concern that a debtor s lease is likely to be one of its most valuable assets. 94 Goode believes that allowing the non-defaulting party to terminate the debtor s lease is equivalent to removing an asset from the debtor s estate, which leads Goode to suggest that England should follow the American practice of banning such clauses altogether. 95 England, however, has not taken steps in this direction. The term flawed assets, which is often used interchangeably with the term limited interests, further adds to the confusion. Flawed assets originally described mechanisms used in financing arrangements to manage the risk of owning assets denominated in foreign currency. 96 These ar- 89 Roy Goode, Perpetual Trustee and Flip Clauses in Swap Transactions (2011) 127 LQR 1 at 8 [Goode, Perpetual Trustee ], citing Re King s Trust (1892) 29 LR IR 201 at 410, Porter MR. Lord Collins references Goode s remarks in his judgment as well (see Belmont, supra note 4 at para 87). 90 Moss, supra note 88 at Belmont, supra note 4 at para See Lord Collins discussion in Belmont, supra note 4 at para 85 of Vice-Chancellor Page Wood s remarks in Whitmore, supra note 80 at , where Vice-Chancellor Wood observed that land being returned to a bankrupt s landlord is not a fraud upon the bankruptcy laws. In Whitmore, a provision in a partnership agreement purporting to transfer a partner s interest in a lease to his partners upon his bankruptcy was, however, found to be void. 93 See e.g. the Butters v BBC Worldwide Ltd appeal in Perpetual Trustee, supra note 67 at paras 3 4, 23 31, The Butters case was heard jointly with the Lehman Brothers dispute in Perpetual Trustee at the Court of Appeal. 94 Goode, Principles, supra note 5 at para Ibid. 96 For a helpful explanation of flawed assets, see Bamford, supra note 46 at paras An English company with a US$100 million asset would borrow US$100 million